Business/ share valuation is an art, rather than science. Not with standing that valuation follows long-established principles, be very wary of websites or software that generates a valuation mathematically; there host of other factors that can affect a valuation. Valuations are required not only corporate transactions, but also for a variety of tax reasons.
The principle, but by no means not the only, approaches to valuation are:
- Cashflow - Determines value by reference to future cashflows (and therefore returns on investment) against a desired rate of return. In practice smaller companies do not have cashflow forecasts.
- Earnings - Historical profits are used as an approximation of future potential returns. A multiple is applied to these to determine value. The multiple is subjective but dependent on a wide variety of factors including the size of the business, the industry sector.
- Net Assets - This approach is particularly applicable to asset-rich businesses (e.g. property companies). Assets are re-valued to market value.
In practice, most small and medium-sized businesses are valued on a earnings and net assets. Discounts will apply for anything but a 100% holding/ ownership.
Ultimately a business is only worth what someone is prepared to pay for it and any valuation will potentially be subject to negotiation with a prospective purchaser/ vendor or HM Revenue & Customs, depending on the purpose of the valuation.
F Ltd was a small contract construction company now in the hands of third generation of the family: A and B who were brothers and C who was their cousin. They were all in their late 50s. The cousin, who had a few other small business interests had reached the Lifetime Allowance with his pension savings. He wanted to leave the business, but the brothers wanted to continue. As a mature company its turnover over the last five years had fluctuated between £800,000 and £1,050,000 on which it had made profits before tax of between £65,000 and £115,000. However, their carefully planned remuneration packages meant that the underlying earnings (after tax) averaged £100,000.
However, over the years F Ltd had acquired a modest portfolio of properties that they had renovated in quite work periods and rented out, but the yard they operated the business from belonged to three directors as individuals.
Acting for the brothers, we valued the company on the basis of its adjusted net assets alone, attributing nothing for goodwill because of the sector in which operated and the likely impact of the cousin leaving the business, but had the properties and plant and machinery revalued. This valued the company at £1,035,000. The shareholders' agreement didn't allow for any discount for a minority holding. The valuation was accepted by the cousin's advisers.
As is common in this type of situation, the brothers didn't have the money to purchase the shares and didn't want to borrow it personally. However, the company had the reserves and most of the cash to effect the acquisition. We proposed that it borrowed some money against the security of its properties and undertook a purchase of own shares. We also made the necessary advance application to HM Revenue & Customs (''HMRC'') to have the payment treated as capital, allowing the cousin to claim Entrepreneurs' Relief and arranged for the brothers' pension scheme to acquire the cousin's share of the yard. HMRC gave the clearance and the transaction was executed to everyone's satisfaction.